WASHINGTON — The Treasury Department is expanding its calls for overhauling regulation of the financial services sector, this time focusing on changes to the most significant rules surrounding securitization and derivatives enacted since the crisis.
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“The U.S. has experienced slow economic growth for far too long,” Treasury Secretary Steven Mnuchin said in a press release. “By streamlining the regulatory system, we can make the U.S. capital markets a true source of economic growth which will harness American ingenuity and allow small businesses to grow.”
Treasury acknowledges that in some areas closer scrutiny of capital markets was warranted following the crisis, but maintains that in many areas it went too far.
“There are significant challenges with regulatory harmonization and efficiency, driven by a variety of factors including joint rulemaking responsibilities, overlapping mandates, and jurisdictional friction,” the report said. “In order to help maintain the strength of our capital markets, we need to constantly evaluate the financial regulatory system to consider how it should evolve.”
But critics said the report represents an unmitigated rollback of rules targeted at the precise kinds of instruments and tactics that contributed to the financial crisis.
“This is almost uniformly deregulatory,” said Marcus Stanley, policy director for Americans for Financial Reform. “There’s no surprise there. It’s clearly very deliberately focused on things that can be done through regulatory action without needing Congress, which from our standpoint raises the threat level.”
Many of the report’s recommendations are directed at market regulations — for example, cutting various policies in order to make it easier for a company to go public and loosening rules for crowdfunding and private equity investment.
But other rules call for reducing the amount of capital required for banks or other entities bundling receivables into tradable securities. Those activities have been prevalent for decades but were also central to the 2008 crash, when banks and other firms bundled subprime mortgages into mortgage-backed securities and then sold them off with little concern for their long-term viability. In response, regulators require securities originators to hold capital against their securities in case they do not perform as expected.
The Treasury report called on bank regulators to “sufficiently account for the magnitude of the credit risk sold or transferred” in calculating that capital requirement.
The report also called on regulators to “consider the impact that trading book capital standards, such as fundamental review of the trading book,” now being considered by the Basel Committee on Banking Supervision, might have on the secondary securities market.
Regulators should also recalibrate capital requirements for securities to prevent “the required amount of capital from exceeding the maximum economic exposure of the underlying bond.”
The Fed’s stress test scenarios should also be changed, the report said, to “more fully consider the credit quality of the underlying collateral and reforms” instituted since the crisis in their assumptions about how assets will weather an economic downturn, the report said.
The Fed should also consider expanding its definition of “high quality liquid assets” to include certain “high-quality securitized obligations with a proven track record” for the purposes of complying with the liquidity coverage ratio and net stable funding ratio, the report said.
The report also seemed not to favor any further regulations on capital markets activities along the lines of the capital and liquidity rules that have been applied to banks — a reining in of the so-called shadow banking sector.
“Inappropriately applying approaches to regulation in U.S. capital markets that are ill suited to our jurisdiction or bank-centric would stifle otherwise vibrant markets while not efficiently enhancing financial stability or consumer protection,” the report said.
The report also called for the simplification of many rules related to derivatives, including margin on uncleared swaps, position limits and greater harmonization of rules between international jurisdictions. The report also called for greater protections for “end-users” — that is, the ultimate consumers of derivatives rather than speculators in derivatives markets.
Industry groups largely lauded the proposals. Rob Nichols, president of the American Bankers Association, said in a statement that the report’s recommendations are “practical, reasonable and achievable” and would help businesses grow and markets flourish.
“We encourage policymakers to take up these recommendations quickly, and look forward to working with them to ensure banks can continue to help our customers and the economy grow,” Nichols said.
Scott O’Malia, chief executive of the International Swaps and Derivatives Association, said that the proposals laid out in the report are largely constructive, particularly the protections for end users and calls for international harmonization.
“We applaud the Treasury for recognizing the benefits of derivatives on the U.S. financial markets by helping firms reduce and better manage their risk,” O’Malia said.
Oliver Ireland, a former Fed official and partner at Morrison Foerster, said the report’s findings, while more indirectly related to banks, are similar to the
“The general theme is consistent with the prior report on banking, which is, ‘We’re looking at whether we got the screws too tight and are impairing innovation and markets and cutting down market liquidity, and so we want to move back in other direction,’ ” Ireland said.
